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It’s been said before, but it bears repeating: American investors are feeling the sting of no longer being spoiled.
For more than a decade, it almost seemed difficult not to make money in the stock market. That all changed in the post-pandemic financial world; 2022 saw one of the most volatile markets in years. Investors have been nostalgic for the “good old days” ever since, today being no exception.
One major player driving market swings in recent years is the Magnificent 7. This ensemble cast doesn’t involve Yul Brynner or Steve McQueen. Rather, it’s the list of seven megacap tech stocks composed of companies with market capitalization higher than $200 billion:
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- Microsoft
- Amazon
- Meta (Facebook)
- Apple
- Alphabet (Google)
- Nvidia
- Tesla
These companies are involved in technologies making headlines around the globe, such as AI, web services and quantum computing. Their success has created a new problem for investors.
A ‘safer’ practice than direct indexing
Common investment advice is to buy the index: Rather than choosing individual stocks, buy into a fund that owns stocks in a given index, such as the S&P 500 or Dow Jones.
This practice is often seen as safer than directly investing in specific stocks because it avoids unsystematic risk.
For example, if you buy stock in Company X, which then experiences a major setback such as a scandal or a significant falloff in business, its stock value will likely decline. If the company can’t recover, you could lose your investment.
Buying an index means you’re investing in multiple stocks simultaneously. Even if Company X is one of them, the other companies that didn’t run into trouble are less likely to decline in value, meaning your overall investment is still sound.
That’s changed a bit: Because the Magnificent 7 are so large, rather than simply being a part of the index, they’re driving it. This is great when things are going well. Those who buy the index are buoyed along by the successes of the Magnificent 7.
In 2024, Nvidia singlehandedly drove more than 20% of the S&P 500’s growth.
It’s great when they’re doing well, but when they’re not…
The flip side is that the entire index frequently suffers when one or more of those seven stocks aren’t doing well.
When the megacap stocks are having a good run, the properly diversified portfolio often underperforms the indexes because, being driven by the Magnificent 7, they aren’t really indexes anymore.
As an investor, that can be tough to watch. It seems as if easy profits are passing you by, but it’s important to remember that markets are cyclical.
Over time, the market has, on average, always risen. However, in between growth periods, there will be times when investments will decline in value. Should that decline happen when circumstances require you to sell before your investments have had time to recover, you could lose money.
An option to consider
There is an option for those who see the value in using indexes to maintain a properly balanced portfolio: Equal-weight indexes.
This approach recognizes that there’s still value in the non-megacap parts of the index and is designed to allow investors to participate without so much exposure to the Magnificent 7.
As I write this, the S&P 500 is down 3.34% for the year. The equal-weight S&P 500 is up 0.97%. It’s easy to see that, while investors who chose the equal-weight index option still lost money, they lost much less than those who bought the full index.
Investors who are worried about a few megastocks having undue influence on their overall returns might find value in such indexes.
If there’s one takeaway from this article, it should be that even easy investing, such as buying the index, can get complicated quite quickly.
Investors should consider working with a fiduciary adviser to help them determine the best strategy for their individual circumstances.
